Meeting Gerard Michael, Founder of SmartLeaf last year at its offices in Cambridge, Mass. was rewarding since his company shares a few things in common with Six Trees Capital LLC (the company behind MAX, the advisor-centric cash management platform). I’m glad to have Jerry as a guest writer for The FinTech Blog.

It’s not news that wealth management is changing. And the change goes deep, affecting everything from the role of the advisor to the mechanics of rebalancing. Even the core value proposition is changing.

So what, exactly, does the “new” wealth management look like? There’s a lot going on. We thought we’d try our hand at describing the changes and the forces driving them.

Value proposition

Let’s start with the core value proposition of wealth management. Historically, the main focus has been on the search for performance. The advisor’s value proposition was that they were experts on stocks and bonds — and, at least implicitly, that the client would benefit from the advisor’s security selection acumen and access to alternative investments.

This is changing. Firms are moving away from value propositions centered on the uncertain task of beating a benchmark and towards value propositions centered on services that the firm knows it can deliver, such as financial planning, coordinating financial service providers, education, etc.

The old:Value propositions centered on the performance value of the advisor’s security selection and active asset allocation.

Why it’s old:Most advisors and firms are not able to deliver performance superior to index investing, and virtually none can do so consistently. Moreover, involving clients in trade decision making is inefficient. Worse, it’s counterproductive: it focuses clients on performance, which they can’t really control, and away from planning, which they can.

Acting as a “coach” and counselor, guiding clients to make wise financial decisions.

Security selection and tactical asset allocation

With old wealth management, the advisor picked stocks from a buy list created by the firm and guided tactical asset allocation, within bounds set by the firm. This is sometimes called “Advisor (or rep) as PM.”

The preferred current approach is to replace buy lists with models selected by an internal investment policy committee (IPC) or a third-party firm.

Why it’s old:Constructing portfolios from buy lists is manual, expensive and error-prone. There’s little evidence that advisors add value through selecting securities or active asset allocation. More importantly, advisors have better ways to spend their time. Others can select securities. Advisors alone can best understand and guide their clients.

The new:
Delegation of security selection and basic asset allocation to third parties or internal IPCs who deliver their best thinking in the form of model portfolios.

Rebalancing, customization & tax management

Traditionally, advisors rebalanced their own accounts, and one of the main rationales for this was that it facilitated customization. It was believed that there was no other way to deliver customization other than to have advisors make per-account manual adjustments to trades.

There’s a better way: centralize rebalancing, parameterize customization and then automate its implementation.The old:Rep (or advisor) as PM — client-facing advisors trading all accounts. Customization and tax management are inconsistently applied “extras” that are implemented manually as “on the fly” adjustments to trades.

Why it’s old:Manual customization and tax management by client-facing advisors is inefficient, expensive and error-prone, and this results in customization and tax management being kept to a minimum. When customization preferences are captured as settings (e.g. “never buy tobacco”), their implementation can be automated and efficiently handled by dedicated specialists, which enables firms to make high levels of customization and tax management standard offerings. And, as with security selection, advisors have better ways to spend their time than manually rebalancing accounts.

The new:Parameterized customization, with implementation delegated to specialists within the firm or to a third party, who oversee a largely automated process. This:

Reduces costs

Increases consistency and compliance

Increases the level of customization and tax management that can be economically provided

The new wealth management is better than the old. It’s better for clients, who benefit from greater customization, superior tax management and more time with their advisors. And it’s better for most advisors, many of whom have struggled uncomfortably with the traditional industry norm of having to project that they add value through superior performance. It is replaced by a steadier, more certain value proposition based on guiding clients to meet their financial needs.

About the Author:

Mr. Michael co-founded Smartleaf in 1999 to reduce the operational burden of managing customized, tax, risk, and expense sensitive personal portfolios. Smartleaf began selling its overlay portfolio management solution to banks, trusts, and financial services companies in 2003, and the company has become a leader in this space with over 50 clients and over $50 billion in assets under management.

Michael Halloran: As a fellow Brown alum who’s gone from a corporate role to a startup, it’s great to connect and tell the story of your fintech company based in D.C.

Odysseas Papadimitriou: Thanks a lot for the opportunity. It certainly has been a wild ride from Greece to Brown to Capital One and, now, WalletHub in Washington. And the team is working on some really exciting projects! WalletHub is the first and only service offering free credit scores and reports that are updated on a daily basis. And we’re building the brain of a financial advisor, to help the people who need financial advice the most but can afford it least.

MH: I was intrigued by your positioning as an AI-based financial advisor that will keep your wallet full instead of empty. I think it’s interesting that many people don’t realize that a financial advisor – whether a real person or an algorithm – doesn’t have to provide investment advice, but could be just offering “advice”.

OP: Unfortunately, the biggest problem for most Americans is just making ends meet. For example, Americans currently owe more than $1 trillion to credit card companies for the first time ever.

So what most people really need is some basic financial advice, from credit card recommendations to advice on getting your credit score in shape before a loan application. And they need it to be free. While such a service might not make financial sense for a traditional advisor to offer, WalletHub can.

Simply put, WalletHub is building individual brains focused on specific categories – credit cards and credit score improvement, for example – that can provide users with personalized advice on the optimal action to take, based on their credit history and stated financial goals as well as simulations with historical data.

MH: Interesting. Your neighbor here in the D.C. area, Michael Kitces, explains better than anyone, I think, the differences between different types of advisors and what is necessary to be registered as a financial advisor, but many people still get confused between investment advice and financial advice, which WalletHub offers.

OP: If that were the biggest misconception people had about money management, whether every day or long-term, we’d be in great shape.

MH: Obviously the major players are Credit Karma and Credit Sesame in this space. How would you contrast what you offer to each of these?

OP: WalletHub is the only service with free credit scores and reports that are updated daily. So we take the centerpiece of these other services and do it even better. And that’s just a small part of what makes WalletHub so interesting. One other big differentiator is that WalletHub puts the consumer first, while these other services are more like billboards for their sponsors.

MH: Recently, NerdWallet stumbled and had to lay off more than 10% of their staff in late 2017 as a result of failing to make their numbers. They had raised $60M in venture capital financing a couple of years ago. Do you think VC funding can contribute to seeking to expand too quickly compared with more of a ‘lean startup’ like yours?

OP: Definitely. VC firms place a lot of bets and rely on a small number of them providing massive returns to pay for the rest. They also have to consistently beat the market to justify charging customers high fees in the face of competition from low-cost index funds. So they’re looking for a big payoff very quickly, and they push companies to their limits to try to achieve that, whether or not it’s really the right thing for the company.

I chose not to take VC money in WalletHub’s early stages because I have a long-term vision for the company and did not want to give up control and see that compromised. And I was fortunate that I didn’t need to take the money, as angel funding and a profitable model have been enough thus far.

But that’s not to say taking VC money is always a bad idea. It can help businesses that are experiencing growth that cannot be funded with more conservative means.

MH: I agree. Venture-backed firms get a lot of funding and support building traffic but can struggle with what to do once that they’ve got a lot of traffic. WalletHub clearly has a well-oiled machine churning out content to drive the customer acquisition efforts for your service. Do you plan to keep providing surveys rating states and cities, or was that more a means to an end of getting to a certain level of traffic?

OP:WalletHub produces a wide variety of content, from serious research reports on the credit card market and consumer debt to fun infographics that educate people about the financial side of popular culture. Our reports ranking cities and states are somewhere in between. But I think they’re successful because they’re useful.

A lot of people would like to take a more analytical approach when deciding where to live, for example, taking into account home prices, job opportunities, cost of living, schools, crime etc. But that’s hard work, and the juice may not seem like it’s worth the squeeze if you have to do it yourself. You might, however, take a look if WalletHub does it… And sure, the topics aren’t always that high minded, but the logic is the same.

MH: Is the use of the term Artificial Intelligence in your company’s description more about distinguishing what WalletHub is looking to do with data and not being simply a media company, or do you intend to be an doing more in AI with your platform?

OP: We’re not just throwing the term AI around, but I do think our use of the technology does differentiate us from competitors, many of which are bloated companies stuck in their old ways. WalletHub uses Python, in addition to MySQL and Golang.

MH: Thanks for spending some time talking about WalletHub. I see that you’re looking to hire both financial writers and engineers, so best of luck as you continue to grow.

OP: My pleasure. We’re always on the lookout for talented individuals who want to change the world one dollar at a time!

I recently caught up with a friend who’s had a very successful career in real estate in Los Angeles. He told me that he tells people who join his firm out of college or B-school that working in real estate is a “get rich slow” plan. I think it’s refreshing to hear that slow and steady can win the race, especially during a time when social media and the hype cycle seems to get more attention.

To me, MAX is a fintech story that is similar to this anecdote. A scale business, not a get-rich-quick scheme, that was bootstrapped and created without venture-capital financing. As some have called it, an accidental company (and a happy one at that).

While I haven’t had nearly as much opportunity to write for The FinTech Blog as I’d like recently, I thought I’d share again on the business I’ve put so much into these last three years as it accelerates its growth trajectory, buoyed by a focused strategy of aligning our efforts with fiduciary and fee-only independent advisor community to reach scale.

In big news, an integration was “soft launched” between Max and Orion so that Max is well on the way past being just a smarter way to get a higher yield on cash while keeping it safe and FDIC insured. Max now enables advisors to help their clients and grow their practice.

Look for more to come with integrations being lined up with leading CRM providers, but what’s exciting is both the platform growth and industry recognition by respected authorities such as Michael Kitces and Joel Bruckenstein, in their recent podcast on “The Golden Age of FinTech.”

Look for big news to come about Max, with platform expansion news and a suite of new functionality and innovations that will be exciting to watch hit to market after keeping our heads down for the last 6-9 months while on the road at conferences like Schwab IMPACT and T3.

We were thrilled to be added to a Schwab’s MarketSquare program – and despite what some have written, have no desire to “compete with Schwab” but rather partner with them to deliver a better solution for held-away cash.

I look forward to sharing the news as it happens, but in the meantime suggest those who are following MAX and our focus on the overlooked asset class of cash and deposits read some of the recent articles about the growth of our business.

We introduced Intelligent Portfolios in March of 2015, so roughly two and a half years ago, and today it has around $20 billion in assets, making it one of the largest robo advisors in the market.

There are a lot of investors out there who don’t want to build their own investment portfolio and don’t want to pay for a professional to do it either, so robo advisors like Intelligent Portfolios are an attractive option.

Ultimately, a pure robo advisor does a few important things for people – it makes it easy to get started and stay on track, provides greater access to pretty sophisticated investment portfolios, and keeps costs low. That’s a proven recipe for better investing outcomes.

2) Intelligent Portfolios holds 6 to ~30% of assets in cash, which is fairly high. What would you say to potential customers who worry that strategy is too conservative?

Our approach at Schwab, and this has been consistent since Chuck started the firm more than 40 years ago, is that cash is an important asset class in a fully-diversified portfolio.

Cash provides portfolio stability and diversification, which most long-term investors value in combination with realistic portfolio returns. In fact, we believe that smoothing out some of the inevitable volatility that occurs over time will keep more people invested and prevent them from trying to time the market, which is nearly impossible to do.

How much cash someone has in an Intelligent Portfolios allocation depends on their risk tolerance and goals, but the typical client holds between 6 to 10 percent, which isn’t abnormal across the investing industry.

We have seen third parties begin to track and compare performance across some of the most popular robo advisors, large and small, and while we believe performance is just one factor investors should care about in addition to costs and progress toward goals, Schwab has consistently been at or near the top when it comes to robo portfolio performance.

Cash provides portfolio stability and diversification…

3) What is your take on Fama-French / Smart Beta? Has Charles Schwab’s research uncovered any benefit to value, size, and momentum?

Schwab Intelligent Portfolios uses a combination of market cap-weighted and fundamentally weighted methodologies to enhance the diversification of the portfolios.

Our philosophy at Schwab is that both index structures should be used in combination to access the core markets and build portfolios with the potential for better results because they perform differently across market cycles.

In the two and half years since we introduced Schwab Intelligent Portfolios, we have seen this level of diversification positively impact performance.

4) Some robo-advisors like Hedgeable have attempted to apply the latest exciting area – AI – towards portfolio management and security selection. What is your take on the role of AI in wealth management?

We are in the early stages of AI making an impact in our industry, but it’s a safe assumption that it will become incredibly important and central to client experience. At Schwab, we’re conducting R&D on AI, determining where and how to deploy it to our client base. Our focus is on utilizing it to enhance

At Schwab, we’re conducting R&D on AI, determining where and how to deploy it to our client base. Our focus is on utilizing it to enhance user experience, rather than portfolio creation or security selection. Today, we’ve got a very experienced team of investing experts who research and design the portfolios used for our robo advisor.

We like to think of Schwab as the original fintech start-up

5) Will Charles Schwab advisers proactively reach out to customers during times of market distress to coach its customers to stay in the market and/or disable access to client funds in times of financial distress?

We would never disable access to client funds, but we certainly have conversations with clients during periods of market volatility and uncertainty. We also post and proactively share a lot of educational content and resources to help clients understand what’s happening in the markets and economy and how our robo portfolios are behaving, and we see strong engagement with that content.

It’s a common misconception that robo advisor clients don’t ever want to talk or interact with a professional. We have clients who are happy to not engage with us, and that’s fine, but we also see significant increases in clients contacting us during market volatility.

For example, during the pretty extreme market volatility in early January 2016 and then again in June 2016 during the Brexit vote, we saw client calls increase around 30 percent and online chats increase between 10 to 15 percent. Most of these clients, 99 percent, didn’t make any changes to their portfolios – they just wanted to talk with a person to confirm they would be okay. If we didn’t have people available to talk with them, who knows how many might have pulled out of the market.

Overall, we think investment advice will increasingly trend toward a mix of technology and live professionals. Schwab Intelligent Portfolios is on the more technology-heavy end of the spectrum, although we do provide access to professionals through this service if clients need them.

More recently, we introduced our hybrid service, Schwab Intelligent Advisory, for people who like to rely on technology, but also want a more holistic financial plan and access to live certified professionals.

Schwab Intelligent Advisory combines an in-depth financial and investment plan, ongoing access to a team of certified financial planners, and automated robo portfolios – the same portfolios we use in Schwab Intelligent Portfolios.

Our new hybrid service has a $25,000 minimum and a 0.28% advisory fee that caps at $900 per quarter, so very much aligned with our focus on making investing and financial planning more accessible to more people.

6) What % of current AUM comes from existing Schwab customers vs. new ones?

About 25 percent of assets in Schwab Intelligent Portfolios are from new clients, and we expect that to increase over time. Among those new clients more than 40 percent are under the age of 40, so we’re seeing a lot of interest from younger investors who are new to Schwab. Overall amongst our retail clients at Schwab, we have $1 trillion of self-directed assets, meaning clients who are investing without any professional advice. We’re finding that Schwab Intelligent Portfolios is an attractive investing model for them, because cost is often a barrier. With Schwab Intelligent Portfolios, investors get a sophisticated automated portfolio without paying any advisory fee, so we’ve removed higher costs as a barrier for them.

7) What would you say to a potential customer weighing the choices between a pure play like Wealthfront or Betterment, versus a legacy broker who’s just getting into the space like Fidelity or Schwab? What factor do you think differentiates Intelligent Portfolios from other robo-advisors, particularly those of existing brokerages? Is the 0% management fee cited most often by clients?

If the growth of robo advice across the industry gets more people invested, then that’s a great thing. We like to think of Schwab as the original fintech start-up that began disrupting Wall Street more than 40 years ago, so it’s a positive thing to have firms of all sizes out there innovating on behalf of investors.

But we think Schwab provides a combination of features and benefits that are unique compared to the smaller start-ups and, frankly, also to the established players who are starting to introduce their own services.

Our clients get the proven stability and security of a firm with than $3 trillion in assets … in addition to services we have available such as Charles Schwab Bank

First, Schwab Intelligent Portfolios is the only automated investing service to charge no advisory fee, commission or account service fees – the only thing a client pays are the underlying ETF fees, which you would pay anywhere you invest, and we build our portfolios with low cost Schwab and third party ETFs.

Second, we’ve built sophisticated institutional-quality portfolios with up to 20 different asset classes, and it’s remarkable to think that retail investors can now access portfolios like this with as little as $5,000 and pay no advisory fee.

Third, our clients get the proven stability and security of a firm with more than 40 years of experience and more than $3 trillion in assets, in addition to the diverse range of products and services we have available such as Charles Schwab Bank and our more than 300 branches across the country.

This guest post originally appeared in FSRankings, which published its interview Tobin McDaniel, Charles Schwab Senior Vice President, Digital Wealth Management. He spoke to FSRRankings about Schwab Intelligent Portfolios, the firm’s robo-advisory offering.

This edition of The FinTech Blog features thought leader Julian Levy, a mentor for the FinTech Innovation Lab in London and well-known advisor to investors in technology, including both venture capital and private equity firms.

The context for FinTech in 2016-2017 requires looking back to the what happened after 2008 financial crisis when unprecedented challenges were faced by incumbents, but many pulled through by restructuring, deleveraging, shedding non-core assets, writing down assets, increasing provisions, and decreasing operating costs.

The road ahead, however, presents challenges and opportunities from new entrants, often called fintech firms, seeking to disrupt the incumbents.

How much is at risk? According to research from Citi, 44% of the business from existing financial services companies could be taken by startups, while McKinsey estimates up to 60% could be taken by fintech firms in the coming decade.

How much is hype?

There are seven areas where fintech firms are challenging incumbents (including
five where it directly involves retail banking): money transfers/foreign exchange, lending, payments, aggregation, and investments.

Foreign Exchange:

Lending:

Payments:

Aggregators:

Investments:

Why Now? There are multiple factors accelerating the rate of change and driving the growth of fintech startups ranging from the current wave of Digital “natives” to new technology, and other factors.

Digital Natives:

New Technologies:

So, what happens next? For incumbents, fear not since banks have massive scale, trusted brands, lots of data, big balance sheets, a physical network, lots of customers and in many cases, an appetite to change (as seen in deals such as the UBS/SigFig partnership, acquisitions, and accelerators, such as the FinTech Innovation Lab).

Meanwhile, the stumbles over the last year by LendingClub, OnDeck, Avant and Prosper show that the startups have plenty to learn as we look ahead to 2018.

Julian Levy is the founder of Ayarma that provides a range of advisory and technology due-diligence services to corporate development teams, as well as venture capital and private equity firms. Earlier he was an executive in residence at Index Ventures where he focused on enterprise technology and advised Key Capital AG on its investments in technology, infrastructure, applications leveraging machine learning and security.

Julian ran Morgan Stanley’s Technology Business Development function across EMEA and Asia after working in Equity Research for Merrill Lynch’s Equity Research team. Previously he led R&D for Merrill Lynch’s technology group in London after starting his career in engineering roles with startups, Credit Suisse and Merrill Lynch.

JH: In 2016, we launched of our first commercial real estate investment trust, MogulREIT I. A REIT is a company that owns or finances real estate.

REITs give their investors the opportunity to participate in large-scale real estate transactions by purchasing shares of the company that owns or finances them. REIT Investors can enjoy regular income, potential capital appreciation, and diversification across geographies, property types, and investment types.

The launch of the REIT allowed us to continue to leverage our technology, experience, data and access to transactions to the benefit of our investors.

With a minimum investment amount of $1,000, the REIT’s primary investment objective is to pay attractive and consistent monthly distributions, to preserve and protect principal, and to offer investors a more balanced and diversified pool of commercial real estate assets nationwide.

MH: What kinds of fees do you charge for your REIT?

JH: Our REIT is a non-traded REIT, which means it is not traded on any stock exchange. Technology has enabled the removal of the middleman and, with it, the average upfront sales commissions of 7%.

MogulREIT I has no upfront selling commissions. And, where traditional non-traded REITs also include an additional 8% in organization and offering costs, MogulREIT I’s costs are significantly less. We charge 3% in combined commissions and upfront costs for MogulREIT I vs. 15%** with similar investments.

Recently, we announced that we can accept investments from self-directed Individual Retirement Accounts (SDIRAs) into our REIT and allow investors to automatically invest their dividends. This provides the possibility to compound returns and makes the REIT even more investor friendly.

Regulation will be key to the development of crowdfunding

MH: It seems like a lot of exciting changes, but for those who aren’t as familiar with RealtyMogul.com, can you summarize how your business works?

JH: With our platform, the investing process is simple and can be done completely online. Investors can browse opportunities and filter by investment type, property or location. Once investors identify a transaction they have an interest in, they can review the entire diligence package and complete the entire transaction online.

MH: Some recent talk in FinTech has been on the new, limited charter “fintech” banking licenses announced recently. RealtyMogul.com as I understand it was enabled by the JOBS Act, correct?

JH: Yes, the JOBS Act, signed into law in 2012, is what gave this space a push and made it all possible. Ever since, there have been many additional regulatory changes to real estate crowdfunding – further proving that the landscape is constantly developing.

Most recently, we saw changes that allowed non-accredited investors to invest in the deals that used to only be available to accredited investors. This may sound like great progress, but there’s still much more to be done.

Regulation will be key to the development of crowdfunding and it is our hope that we will see the SEC and FINRA continue to create new regulations that are more suited to how we conduct business on the internet today but still protect investors.

MH: Good luck presenting at LendItUSA 2017 and thank you for helping advance the debate and promote the role that FinTech can play in real estate finance.

JH: Thanks for letting us share our story with the potential investors and borrowers and those who follow developments in FinTech.

Jilliene Helman is the CEO and Founder of RealtyMogul.com, responsible for overseeing the strategic direction and operation of the business. She is a Certified Wealth Strategist and holds Series 7, 24 and 63 licenses. Previously, she was a Vice President at Union Bank, a unit of one Bank of Tokyo-Mitsubishi UFJ. She has underwritten over $5 billion of real estate and holds a degree in Business Administration from Georgetown University.

Michael Halloran is the Publisher of The FinTech Blog but spends most waking hours as Head of Business Development and Partnerships for MaxMyInterest where he is responsible for the growth of the Max For Advisors program, a solution for financial advisors and their clients to earn a higher yield on cash, obtain broader FDIC coverage and automatically earn more as banks increase their rates. Previously, Michael was with Morgan Stanley where he led its strategic partnership team for the global wealth management group. He was a BA from Brown University and MBA from London Business School.

Interested in seeing Jilliene Helman speak at LendIt USA 2017? It’s not too late to register for tickets. Readers of The FinTech Blog can obtain a discount of 15% by using code FBLOG17USA when they sign up!

** A 2012 study by the Securities Litigation and Consulting Group found a mean selling commission of 7% and organization and offering expenses of 15% among the offerings it reviewed.